How Much of Your Income Should You Invest?

If you’re just getting started with investing, you may be asking yourself how much of your income you should invest. Many experts recommend investing 10% to 20% of your income, but how much you can afford to invest depends on many factors.

Fortunately, it doesn’t cost much to begin investing—some platforms let you get started with as little as $1. The key to making your investment pay off is to contribute regularly so you can benefit from more time in the market.

Investing vs. Saving

Investing and saving both involve putting money away for the future, but they’re not the same. The difference is in your goals and timeline for the money, and the level of risk involved. Understanding when to save and when to invest is important for deciding how much of your income to invest.

Saving is setting aside money in low-risk bank or credit union accounts so you can easily access it in the near future. When you’re focused on saving money, you’ll typically opt for accounts that protect against losses. For example, you may deposit money in a high-yield savings account or certificate of deposit (CD) at a federally insured bank or credit union. You won’t earn a significant amount of interest, but the risk of losing money is very low.

Investing involves buying assets such as stocks, bonds, mutual funds and more, with the hope that you’ll earn a profit over time. Investments have the potential for higher returns but also carry a higher risk of losing money. The degree of risk depends on the kind of investment, for example, stocks, bonds, mutual funds and the like.

Saving and investing are both important parts of a solid financial foundation. To balance the two, some financial experts recommend saving 5% and investing 15%.

Short-Term Savings Goals

Consider saving money in an account where you can access it quickly for short-term goals or needs. If you think you may need money within the next five to seven years, keeping it in a savings account, or other safe interest-bearing account, is often best.

You might put money in a savings account for your:

  • Emergency fund
  • Down payment on a home or car
  • Wedding
  • Vacation
  • Upcoming expenses

Long-Term Investment Goals

It’s best to invest money you don’t expect to need for several years. This gives your investments time to grow significantly with the help of compound interest and allows you to ride out market fluctuations.

You might use investments for:

How Much Should You Invest?

While 15% is a good target to aim for, it won’t work for everyone. The amount you can afford to invest may change over time based on how your life and finances change.

Securing your financial foundation is an important step to take before you invest a significant portion of your monthly income. If you don’t have an emergency fund, make it a priority to save three to six months of basic living expenses to cover financial emergencies. Paying down high-interest debt, such as credit card balances, is another smart move to save money that you can then put toward investing.

Examine your cash flow to understand how much extra money you have for investing. Start with your monthly income, then subtract your expenses and what you’re setting aside in savings, and take a look at how much you’ll have left over. This is how much you can potentially invest each month. If it’s more than 15% of your monthly income and you can afford to invest more, you should. The more you invest, the more capital you have for potential gains.

On the other hand, don’t put off investing because you have less than 15% of your income available to invest. Instead, invest what you can afford or try reducing or eliminating some expenses to free up money that you can invest. If you’ve cut all you can from your budget, look for other opportunities to add to your investment allocation. For instance, you can invest your tax refund, commission, holiday bonus and other lump sums of cash or windfalls to boost your investment portfolio.

How to Start Investing

Once you’ve figured out how much income you should invest, the next step is to get started. You have several options for investing, either on your own or with some help.

401(k)

If your employer offers a 401(k) plan, this is one of the easiest ways to get started. With a 401(k), you can invest pretax dollars, reducing your current taxable income and delaying taxes on both your contributions and earnings until you withdraw the money in retirement. Your contributions are automatically deducted from your earnings and invested in the assets you choose from the plan’s offerings.

If your employer matches a portion of your contributions, you should take advantage of it—it’s essentially free money that goes toward your retirement. Make sure you understand how long you need to stay with your company to be vested. Leaving too early could forfeit some or all of your employer match.

IRA

If you don’t have access to a 401(k), an individual retirement account (IRA) is a good investing option. An IRA is a tax-advantaged savings account that helps you save for retirement. With a traditional IRA, you contribute pretax earnings and postpone paying taxes until you withdraw from your account during retirement. A Roth IRA allows you to invest after-tax dollars and then make tax-free withdrawals in retirement, provided your account has been open for at least five years. The amount you can contribute each year is limited based on your age, filing status, income and IRA type.

Robo-Advisor

If you’ve maxed out your 401(k) or IRA contributions, or you’d like an investing option that won’t penalize you if you cash out your investments before retirement, you’ll need to work with a brokerage. A cost-effective way to invest through a brokerage is with a robo-advisor. Robo-advisors are online automated platforms that help you create a personalized investment plan based on your investment time horizon, risk tolerance and estimated return. Some platforms charge fees, but they’re less expensive than working with a broker. Still, you’ll want to compare apps to find the best option.

Financial Advisor or Stockbroker

Working with a financial advisor or stockbroker may be better than using a robo-advisor if you want to talk through your investment plan with a person and have that person manage your portfolio. This is the more expensive route, but can be beneficial depending on the amount you have to invest and help you’d like.

All investments involve the risk that you could lose some or all of your money. Consider how much risk you’re willing to accept—in other words, your risk tolerance. This plays an important role in the types of investments you take on and the amount you invest in each.

The Bottom Line

Investing 15% of your income is generally a good rule of thumb to meet your long-term goals. Even if you can’t afford to invest that much today, you can still start investing with what you can afford. Your investment amount may fluctuate as your cash flow changes, but staying consistent can pay off in the long run.

The post How Much of Your Income Should You Invest? appeared first on Experian’s Official Credit Advice Blog.

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